Even though residential market are booming while commercial properties languish, there is an increasing national trend to shift more of the state and local property tax burdens to commercial real estate.  On the surface, that my seem illogical.  After all, if vacancies are high, shouldn't hard-pressed owners at least get a little tax relief?  But think a little deeper and the reason will be obvious.  "After all, buildings don't vote, but homeowners do," quips John Garippa, an attorney with Garippa Lotz & Giannuario and president of the American Property Tax Association.

In state after state, residential owners who have been thrilled with property value jumps that saw the median price of a U.S. home rise 20.8 percent over the last three years (according to NAR's Research Department) are a little less thrilled about seeing corresponding jumps in property taxes.  The result is that in states including California, Minnesota, Pennsylvania, New York, and Massachusetts, legislatures are proposing, and in a few cases passing, resolutions that would make property taxes more onerous for commercial property owners and their tenants.  Property taxes on business property (owner-occupied as well as investment) already totaled $153.1 billion in FY 2003, according to a study prepared by Ernst & Young for The Council on State Taxation.  This amount accounted for 39 percent of all tax revenues collected by states.  

Separate and Unequal
Currently, fewer than a dozen states allow property classifications that permit residential and commercial property to be valued at different rates, according to the International Association of Assessing Offices.  But that doesn't mean that inequities don't exist.  For more than a decade municipalities in California, home of tax busting Proposition 13, have used special assessment districts to circumvent Prop. 13's  2-percent a year value increase.  Now California lawmakers are proposing a constitutional amendment that would bypass Prop. 13 and allow commercial buildings to be assessed at a higher rate.  Called the Improving Classroom Education Act, this proposal would levy an additional 0.55 percent on commercial real estate, including multifamily properties.  In a January article in The San Francisco Business Times, Rex Hines, president of the California Business Properties Association, estimated that this measure could cost California property owner's $8 billion annually.

Another proposal, says Cris O'Neall, president of Rodi, Pollock, Pettker, Galbraith & Cahill in Los Angeles, would try to put a new twist on the rule under Prop. 13 that allows a property to be re-evaluated when it's sold.  O'Neall explains that currently, assessors define change of ownership not as just sales, but as transfers of a majority interest in a closely held entity owning real property.  Under the proposed rule, changes in ownership of more than 50 percent of a publicly owned company's stock would also constitute a change of ownership.  Under this scenario, a public company that saw 50 percent of its stock change hands in the market every three months could have its California property reassessed that frequently.  "What government doesn't seem to realize is that most of these increases will end up at the door of the consumers.  Renters will have to spend more of their incomes for housing, and commercial tenants will feel the result in higher pass throughs," says Harvey E. Green, president and CEO of Marcus & Millichap in San Francisco.

But even if some costs can be recouped from tenants, higher taxes can have a very real impact on value, says Dr. John F. McDonald, professor in the College of Business Administration at the University of Illinois at Chicago and author of "Property Taxes and Commercial Real Estate Values in Urban Areas."  In this 1996 study of the Chicago CBD office market, McDonald concluded that a $1 per square foot increase in property tax will reduce value by $10 psf, assuming that only half of the tax increase can be passed on to tenants.

Massachusetts is another state that is looking toward commercial real estate for additional income.  A new law signed by Gov. Mitt Romney in January 2004 will allow Mass. cities to levy taxes on commercial properties at 200 percent of the levy for residential properties, up from the prior 175 percent.  The measure, which has already been approved in Boston, was adopted because residential property values in the state have increased as much as 40 percent at the same time that many commercial values have fallen, says Thaddeus Jankowski, CEO of the Greater Boston Real Estate Board and former Boston Assessing Commissioner.  For commercial properties that have declined in value because of Boston's 20-percent vacancy rate, the actual tax increases may be minimal, says Jankowski.

Yet even without this last increase, commercial property taxes in Boston have been climbing steadily for the last decade, says Webster A. Collins, executive vice president and partner with the CB Richard Ellis Valuation and Consulting Group.  "in one high-rise office building in the Boston CBD, property taxes account for 47.44 percent of total operating costs.  That averages out to %10 psf."  Collins notes that building owners angered by paying 20 to 30 percent of total gross revenues for property taxes prompted the historic Tregor decision, which helped lower Boston property taxes in the 1980s.  "We've more or less reached that point again," he says.

What is Fair Market Value?
The hit will be much more significant on Boston properties that have sold recently to capital-heavy investors.  It will be very hard to get a lower assessment on an arm's-length sale of a property, even if it's not fully occupied," says David G. Saliba of Saliba & Saliba in Boston.  A case could be made, however, if an investor paid top dollar for reasons other than value based on NOI, says Saliba.  "The devil is in the cap rate.  I've heard the argument that because of low interest rates, investors are willing to accept lower yields, which is letting values and taxes rise."

"With so much capital in the markets, some investors are trading properties as commodities instead of as real estate, holding them for short periods of time as you would a stock.  This technique produces sale prices based on investment value instead of a true fair market value for assessment purposes," says James P. Regan, an attorney with Fisk, Kart, Katz and Regan, Ltd. in Chicago.

But disconnects can occur in other ways and still have a tremendous effect on a building's taxes.  A perfect example is The Denver Technological Center.  The 9 million-square-foot office park straddles two counties - Denver and Arapahoe.  Identical buildings on different sides of the line have taxes that vary by $2.00 psf, says Dave Tilton, senior managing director with Frederick Ross Company, a part of ONCOR International.  While Arapahoe - the higher side - remains Denver's fastest growth area, its need for more infrastructure and thus more taxes is creating a burden for commercial property owners facing 20 percent vacancy, says Tilton.

Inconsistencies in appraisals can't always be blamed on geography, however.  In McDonald's 1996 study, he found that in downtown Chicago, half the commercial properties then on the rolls were assessed outside the 16.4 percent to 31.4 percent median range of all properties - some high, some low.

Recognizing that inconsistencies can occur, many commercial property owners and managers appeal their taxes every year as a matter of course.  That's usually a good strategy.  But do your own calculations of value before you appeal, suggests Garippa.  I've seen appeals in which owners ended up with increases in their assessments.  Today, taxing jurisdictions need the revenue, so they get their own attorneys and appraisers to countersue when an appraisal is challenged.  The days of going in and having a chat with your friendly appraiser are over."